Fechko v. Commissioner
| Decision Date | 30 December 1992 |
| Docket Number | Docket No. 12797-91. |
| Citation | 64 T.C.M. 1638 |
| Parties | John R. Fechko and Suzanne Fechko v. Commissioner. |
| Court | U.S. Tax Court |
Respondent determined deficiencies in petitioners' Federal income tax and additions to tax as follows:
Additions to Tax
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Sec. Sec. Sec
Year Deficiency 6653(a)(1)(A) 6653(a)(1)(A) 6661(a)
1986 .......................... $17,246 $862 1 $4,312
1987 .......................... 17,190 860 2 4,046
1 50 percent of the interest due on $17,246
2 50 percent of the interest due on $16,183
Respondent also determined that petitioners are liable for the increased rate of interest provided in section 6621(c) for both 1986 and 1987.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.
The issues in this case arise out of petitioners' interests in three tax shelter programs known as Gifts Advertising (Gifts), Bingo Leasing (Bingo), and Pairware Research & Development (Pairware) (collectively the Programs). With the exception of the question of deductions for petitioners' unreturned out-of-pocket expenditures made to acquire interests in the Programs, petitioners have stipulated respondent's adjustments in petitioners' Federal income tax liabilities for the years at issue. After concessions and stipulations, the issues that remain for decision are:
(1) Whether petitioners are liable for additions to tax under section 6653(a) for negligence or intentional disregard of rules and regulations;
(2) whether petitioners are liable for additions to tax under section 6661(a) for substantial understatement of income tax; and
(3) whether petitioners are liable for increased interest under section 6621(c).
For the reasons discussed below we hold that petitioners are liable for additions to tax under sections 6653(a) and 6661(a) and increased interest under section 6621(c).
The facts that have been stipulated are so found, and we incorporate them by this reference. Petitioners resided in Rocky River, Ohio, when they filed their petition.
Petitioner John R. Fechko was a police chief in Seven Hills, Ohio, during the years in issue. Mr. Fechko is a high school graduate, has had some "in-service" training while in the Marine Corps, and studied constitutional law at Kaiser Community College for one academic quarter in the early 1970s. He has had no training in accounting, business, marketing, advertising, or income taxation. Prior to buying into the Programs, Mr. Fechko had invested in a savings plan at his local bank and had prepared his own income tax returns. Petitioner Suzanne Fechko has a bachelor's degree in business administration from Baldwin-Wallace College. During the years at issue, she was a sales representative for Franklin Oil of Ohio.
In 1985, petitioners were introduced to Graham & Associates through a personal friend. Mr. Fechko met with John Graham three times that year before he "became a client of Graham & Associates". During 1985, at John Graham's inducement, Mr. Fechko acquired an interest in a tax shelter program leasing ice cream vending machines. Petitioners thereafter became clients of John Graham's brother, Thomas A. Graham (Graham), and his associate, Marie Rady. Graham styled himself an investment counselor, tax expert, and financial adviser, and offered petitioners opportunities to acquire interests in Gifts, Bingo, and Pairware. In 1986 and 1987, petitioners made payments to acquire interests in the Programs as well as a fourth program, not here at issue, known as Sun Valley Limited.
There is almost no evidence in this record that describes how the Programs purported to operate. However, it is clear that the Programs are identical to those in Klieger v. Commissioner [Dec. 48,716(M)], T.C. Memo. 1992-734; see also Cross v. Commissioner [Dec. 48,695(M)], T.C. Memo. 1992-715 (Bingo).1
Graham told petitioners that an interest in the Programs would enable them to defer taxes on their current income through tax deductions and credits until they were later making profits on their investments. Graham advised petitioners to reduce their income tax withholding by increasing the number of exemptions claimed on their withholding certificates (Forms W-4) and to use the extra take-home pay to make the initial payments to acquire interests in the Programs. Petitioners then signed notes for the balance due under their agreements to acquire interests in the Programs.
Graham & Associates, through its tax return preparation division, Management Accounting Tax & Service, prepared petitioners' 1986 and 1987 Federal income tax returns at no additional charge. Petitioners understood that if they were audited by the IRS, Graham & Associates would represent them at no additional charge.
Petitioners did not seek any independent professional advice on either the economic feasibility of the Programs or their purported tax benefits. Petitioners did not feel impelled to seek outside advice because they regarded Graham & Associates as their tax and financial advisers. Nor did Petitioners try to verify independently the professional expertise or reputation of Graham & Associates or any of its personnel. Mr. Fechko felt no need to make an investigation along these lines because Graham & Associates had passed his self-formulated "test" of sound tax practice: Mr. Fechko believed that the IRS had approved Graham & Associates' Programs because he received a refund in 1986 in the exact amount claimed on his 1985 income tax return plus 11 percent interest, and that his investment in John Graham's ice cream vending machine program, as reported on petitioners' 1985 return, had survived scrutiny by the IRS's "tax abuse shelter unit". Mr. Fechko also felt comfortable with the Programs because he had told John Graham that he did not want to get involved in any illegal tax shelters, in view of his position as a police chief. Mr. Fechko's "test" did not include any measurement of the Programs' economic feasibility or profit potential.
On August 10, 1987, petitioners filed an amended 1986 income tax return (Form 1040X), prepared by Management Accounting Tax & Service, that reported a $423 refund due. The reported changes were attributed to two mistakes, not here at issue, made in the alternative minimum tax computation on Form 6251 attached to their original return. It appears that this refund was not approved by the IRS and was never paid. This amended return did not disclose any of the tax shelter items reported on the original return or purport to change any of the tax treatment of those items.
In 1986 or 1987, Mr. Fechko realized that he was not going to make any profits from his investments in Graham's programs. Although Graham had repeatedly promised substantial returns on the investments, Mr. Fechko never received any money with respect to any of the Programs.
The Programs were sham transactions without economic substance.
OpinionPetitioners have stipulated that they will be bound by the Court's decision on the cross-motions for partial summary judgment in Omerza v. Commissioner, docket No. 24138-90, on the question of whether petitioners were entitled to loss deductions under section 165(c) for their unrecovered out-of-pocket expenditures to acquire interests in the Programs.
In Omerza v. Commissioner [Dec. 48,135(M)], T.C. Memo. 1992-206, we held, even though it was stipulated for purposes of the cross-motions that the Omerzas acquired an interest in Gifts with the intent of making a profit, that they were not entitled to a loss deduction under section 165(c)(2) for their $3,200 initial cash outlay because it was also stipulated that Gifts was a sham transaction without economic substance. In Omerza v. Commissioner, supra, we also held that petitioners were not entitled to a theft loss deduction under section 165(c)(3) in 1986 for their unreturned $3,200.
As a result of their stipulation to be bound by our decision in Omerza v. Commissioner, supra, and their stipulation that the Programs were sham transactions without economic substance, petitioners are not entitled to any deductions under section 165(c) in 1986 for their unrecovered cash payments to acquire interests in the Programs. By reason of their stipulation, petitioners are liable for the deficiencies in Federal income tax determined by respondent. The remaining issues are their liabilities for additions to tax.
Section 6653(a)(1)(A) imposes an addition to tax equal to 5 percent of the underpayment due to negligence or intentional disregard of rules or regulations. If any part of the underpayment was due to negligence or intentional disregard of rules or regulations, the 5-percent addition to tax is imposed on the entire underpayment.
Section 6653(a)(1)(B) imposes an addition of 50 percent of the interest payable under section 6601 on the portion of the underpayment attributable to negligence or intentional disregard of rules or regulations.
We have found taxpayers liable under section 6653(a) for claiming income tax deductions in connection with sham transactions without making a reasonable investigation into whether they were entitled to such deductions or credits, and without reasonably relying on the advice of an independent financial or tax adviser. See, e.g., Rybak v. Commissioner [Dec. 45,042],...
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